Year-End Planning 2019

It’s hard to believe that the decade is coming to an end, but as we approach the end of 2019, individuals and businesses may have unique opportunities to creatively boost savings, make investments, transfer wealth, implement certain tax strategies, and more. Proper planning and implementation now, with over two months remaining in 2019 can save a lot of headaches and rushed decision-making during the final days December. So much of wealth planning can be dictated by tax-consequences and as a result, planning around year-end is crucial since many tax considerations are measured based on a taxpayer’s calendar-year ending in December.

Below are 10 planning areas where various individuals & businesses may consider implementing meaningful strategy before 2019 is through.

manage certain retirement & tax-favored accounts

Properly managing and understanding your retirement & other tax-favored accounts and the contribution/distribution rules for them is essential to most good year-end planning.

For those fortunate to have a retirement plan available through their employment, it is often wise to ensure that the annual contribution limit of at least your employee deferrals is being reached if your financial plan can afford it. For a 401(k), the most common employee retirement plan in America, the employee deferral limit in 2019 is $19,000. Whether a 401(k) or any other pre-tax retirement account, each dollar contributed will defer current income that your ordinary tax rate would have otherwise been applied to, causing more current taxes. The higher your current income is, the more valuable maximizing these contributions may be as you’re likely to be in a higher tax bracket. Since you are limited to the amount you may contribute to a given plan in a given year, taking full advantage of this while you still can in 2019 may be a crucial component of your long-term financial and tax plan, and repeating this each year as applicable. Those that receive year-end bonuses or commissions should consider proactively determining if a portion of their payouts can be applied towards 2019 contributions. Whether a retirement plan or other tax-favored accounts, employees should be certain to take full advantage of any “free money” offered through an employer match, if their budget can afford it.

Aside from retirement-specific plans, many employees of established companies may have the opportunity to engage in Health Savings Accounts, Flexible Spending Accounts, Transit Benefit Accounts or Dependent Care Benefit accounts - among others. As your life and financial plan may allow, maximizing these benefits can be another great way to defer (or even eliminate) taxes while deriving a valuable benefit. These benefits also have annual limits and therefore it makes sense to ensure that, where possible, they are being strategically maximized. Often times an employer will contribute towards these other tax-advantaged plans to a degree as well.

2. Make use of Tax-Loss Harvesting and Carryovers

As the tax laws typically revolve around calendar year-end, it is often important for taxpayers to strategically focus on accelerating deductions into the current year if it will help minimize their overall tax burden. Particularly, for those with taxable investment accounts, this could mean trying to find and realize capital losses before the year is through which can be used to offset capital gains or typically up to $3,000 of ordinary income (exceptions may exist however).

For example, if a taxpayer had realized $5,000 of capital gains during the year but may have $8,000 of unrealized losses, it may make sense to realize those losses before year-end. From a tax perspective, the losses may eliminate the entire capital gain and an extra $3,000 may be used to further offset ordinary taxable income.

Be careful however when harvesting losses. While it can be a wise strategy, wash sale rules can disallow losses if substantially identical securities are dealt in close proximity to one another. Wash sales exist to prevent investors from selling securities at a loss (for tax benefits) and simply repurchasing the same (or very similar) investment too soon thereafter.

For those that have unused realized losses from prior years, they may carry over into the current year. While this situation may be more rare considering that markets have generally performed well in recent years, poor investments can still occur and if losses were realized, planning how to best utilize these carryover losses in a strategic manner can become crucial prior to year-end.

3. implement smart Business Tax planning

There are many savvy ways businesses may be able to plan for and manage their tax and financial impact around year-end. Below is a summary of a few crucial concepts for business owners to consider.

Ensure that your entity selection aligns with your business. The most common forms of business organization is sole proprietorship, limited liability company (LLC), limited partnership, S Corporation and C Corporation. These each may pose different legal, management and tax opportunities. Be certain to know what each can offer and that it aligns with your business needs and goals.
Understand your choice of accounting method. The 2017 Federal Tax Reform, implemented new opportunities for businesses that were previously accrual-basis accounting to switch to cash-basis accounting for tax purposes. If you have a business with large receivables or payables it may make sense to consider whether changing your accounting method for book/tax purposes could lead to large tax savings by shifting income/deductions. Either way, based on the type of accounting method you choose to (or must) use, you will want to consider ways to increase deductions or delay income events around year-end to best manage tax impact.
Consider ways to accelerate deductions or defer income. For businesses that need to buy equipment, they generally are permitted to “depreciate” the property over it’s useful life, booking an expense for tax purposes each year that can be used as a deduction from their taxable income. Typically businesses must capitalize these assets and follow this depreciation rather than taking an immediate expense.

Businesses that purchase tangible personal property with a useful life of 20 years or less (and some other certain assets) may be eligible for “bonus depreciation”. Bonus depreciation allows for the business to immediately expense the entire value of the purchased asset and therefore receive an immediate income tax deduction. The 2017 Federal Tax Reform made bonus depreciation equal to 100% of the asset’s value through 2022, after which it is set to be reduced. Therefore, if large, depreciable asset purchases are required over the next few years, it may make sense to strategically plan for them. If 2019 is a year with high-income and a potential need to acquire more equipment, it may be wise to do this prior to year-end. Similar to the bonus depreciation, many business owners may look to make use of the Sec. 179 depreciation deduction which is very similar to the bonus deduction. It allows for the immediate expensing of certain purchased assets up to lower limitations than bonus depreciation. There are more nuanced rules regarding bonus depreciation and Sec. 179 that are beyond the scope and purpose of this article. For more information on depreciation methods, please consult a tax professional.

Aside from accelerating deductions through depreciation, a business may want to consider implementation of certain benefit or retirement plans that may be able to assist owners in saving for retirement in a tax-favored way and prevent income from being recognized in 2019 - pushing that income into a later year. Certain plans may not be able to be established for 2019 at this point, but other, more simple plans can still be established up until the end of 2019 and can lead to significant tax efficiencies or savings if managed and planned for properly.
Understand and make use of the Qualified Business Income (QBI) deduction where permitted. 2017 Federal Tax Reform introduced IRC Sec. 199A which allows for a potential 20% deduction of QBI for certain pass-through entities. This is a complex and new area of the tax code and should be examined with the guidance and advice of a qualified tax professional. Proper planning may show significant savings if a business may qualify for this unique deduction.

4. Review your benefit enrollments & Insurance options

October and November are the most common months of the year for employees to have open enrollment at work. During open enrollment, employees are able to make changes to their workplace benefits that otherwise may not be eligible for change unless a qualifying life event occurs prior to their next enrollment period. It is important to review health, life, disability and other insurance options that your employer provides as well as compare that with any existing (or lack thereof) private coverage available to you. Understanding and properly evaluating both a) your benefit needs and b) your available options provided by your employer - can help better understand your planning needs. Now is often the time to be proactive on this front before open enrollment periods close prior to year-end. If you don’t understand your benefits and how they fit into your overall financial plan, be sure to consult with an advisor or other qualified professional.

5. demonstrate thoughtful investing

It may sound simple, but a lot can be said for using common sense when investing. While we don’t believe in market timing at Hudson Oak, we do think that understanding when to buy or not buy an investment product can make sense. For example, investors should avoid unnecessarily investing into funds within their taxable accounts that have large capital gain distributions before year-end. Most registered funds (particularly mutual funds) are required to distribute their earnings to shareholders each tax year. If a mutual fund held underlying investments that produced sizeable income, or the fund realized gains itself from selling investments, that fund periodically must distribute those earnings to the underlying fund shareholders. Some of the distributions occur routinely, however the largest often happen in December. Buying into a fund towards the end of the year and unknowingly receiving a taxable distribution as a result may yield unintended tax consequences that impacts other tax planning. Understand what you are investing into and when it makes sense to purchase certain products.

6. family wealth transfer opportunities & tax rate arbitrage

For those with means and a well-designed and sustainable financial plan, sharing wealth with loved ones can be a beautiful thing. If a family’s wealth could be subject to gift or estate taxes, it may be wise to make use of certain gifting strategies each year. In 2019, an individual can gift up to $15,000 per year to any other person without having to file a gift tax return. This amount is considered the "annual exclusion” amount. If the donor has a spouse, they may elect to “gift-split” and double the amount they can provide to a single recipient, without tax implications. If a donor has 3 recipients they would like to benefit, and they are looking to transfer wealth efficiently during life, they may consider gifting $90,000 per year through gift-splitting without incurring any tax implications. Once the year has ended, the opportunity to transfer the amount of the annual exclusion for that year is no longer available.

While benefiting future generations or loved ones may be the primary reason for gifting during life, strategic tax opportunities may exist as well. Suppose the donor above has $90,000 of highly appreciated investments that are also causing their portfolio to be out of balance. If we assume the scenario in the previous paragraph, the donor may be able to transfer those appreciated securities - rather than cash - to three recipients. If the recipients are in a lower tax bracket than the donor, the donor will have reduced the overall tax impact upon a sale, avoided gift tax implications and potentially rebalanced their portfolio as a result. Of course, there are many other factors that should be considered, but the fact is that with only a limited amount that may be transferred each tax year without implication, wealthy families should properly plan and consider how to use their annual exclusion effectively.

There are possibilities to utilize this fundamental gifting principal with more sophisticated estate and gift techniques such as through Grantor Retained Annuity Trusts (GRATs), Family Limited Partnerships (FLPs) and more. Those advanced planning techniques are beyond the scope of this article, but can be a useful way for families to strategically transfer wealth each year.

7. use appreciated investments with Charitable Planning

It has long been known that charitable giving can lead to attractive tax benefits. If you are experiencing a larger income year, then donating to charity before year end may be able to help mitigate your tax impact for 2019.

Giving to charity is often most effective when done by donating appreciated securities. This is a way for investors and taxpayers to benefit a charity without having to ever realize the tax embedded in an investment due to its appreciation. In a perfect scenario, an investor can rebalance their portfolio by gifting an investment that has appreciated, obtain a useful tax deduction, and also meet their charitable intent.

For those that perhaps incurred a large tax event and are looking for a way to reduce their taxes for 2019, but aren’t sure what charity they want to benefit at this moment, the use of a donor advised fund (DAF) may be appropriate. A DAF is a conduit fund where a donor can irrevocably pledge appreciated investments to and receive a charitable tax deduction for the year in which the pledge was made. Then, in the future once the donor knows what charity they’d like to benefit, they may use the DAF to distribute funds to a variety of charities without incurring any tax. With the individual standard deduction being higher following 2017 tax reform, it has become less common for taxpayers to itemize their deductions - which includes the charitable deduction. For most, only larger charitable gifts will increase their itemized deductions to a point that it will exceed their standard tax deduction. As a result, the use of a DAF can be an effective tool in charitable “lumping” by only pledging/donating in years when large income events are occurring and the deduction will be most valuable - then distributing to the charities of choice whenever the donor pleases.

Another unique charitable giving option directly from an investment account is the use of a Qualified Charitable Distribution (QCD). Individuals with an IRA that are required to be taking their required minimum distribution can instead elect to have up to $100,000 each year directed from their IRA directly to a qualifying charity of their choosing. As a result, the amount of the donation that would have otherwise been a required taxable distribution and included in the taxpayer’s income avoids income exclusion, and therefore taxation, because it went directly to a charity. For those with large IRAs, above age 70, and that have real charitable intent, this is a potential planning technique that should be considered prior to year-end, especially if they have not taken their full RMD and are at risk of being pushed into the next tax-bracket. This is also a great way to give to charity in years when your income is not as high and you would not receive the separate charitable deduction due to not being able to itemize on your tax return.

We encourage you to work with a qualified tax or financial professional to determine whether a DAF or a QCD may be more appropriate for your specific situation in any given year.

8. consider Opportunity Zone Investments

Qualified Opportunity Zone (QOZ) funds are certainly a hot topic over the last 2 years. We’ve written about QOZs before, but in qualifying situations these opportunities (no pun intended) can make sense. For real estate investors looking for optimized gain deferral, investment into a QOZ fund prior to the end of 2019 can result in a 15% gain deferral. Investments after 2019 and before 2022 will only be eligible for 10% gain deferral. Therefore certain investors looking to take full advantage of the deferral opportunities within a QOZ fund may want to be certain to invest prior to year-end 2019 rather than in 2020 and beyond. QOZ funds are a new part of the tax code and require deep understanding and guidance of a qualified tax professional, however for many in this space, the time is now before year-end to consider if it is an appropriate part of your financial plan.

9. IRA contribution & conversion strategies

Each year an individual with sufficient earned income can make a contribution to a Traditional IRA of up to $6,000 ($7,000 for those eligible for catch-up contributions). For some this contribution can make sense, even if they otherwise think they may be in excess of the IRS limits. Since there is only a limited amount that can be contributed to an IRA each year, taxpayers that may be eligible should consider whether a contribution makes sense for their financial plan.

Additionally, before the end of the year, taxpayers should consider whether a Roth IRA conversion could make sense. A conversion is when a Traditional IRA owner chooses to convert a portion of their IRA to a Roth IRA. In doing this, the taxpayer will recognize ordinary income equal to the amount of the conversion - assuming all dollars were previously deducted upon contribution. This is an appealing strategy most often in two situations.

First, when a taxpayer believes their current income tax bracket will be lower than their future income tax bracket for those same dollars, by effectively accelerating the tax due to be paid now, the assets can then grow and be used tax-free in the Roth account.
Second, when a taxpayer has experienced a large tax loss, such as a business loss that flows to their personal tax return, or perhaps the release of a previously suspended passive activity loss from the sale of real estate or an investment. In this instance, normal income may be pushed quite low, and as a result accelerating income realization by converting an IRA could be a smart tax and financial planning decision to pack income into lower tax brackets than would normally be possible in other years.

10. Manage Equity award Events and company stock within a retirement 401(k)

We’ve written extensively on various options, ESPP, and company stock planning in 401(k)s among other various company stock topics. Ahead of year-end is a time to consider if it makes sense to act on any of these topics as your 2019 tax picture has become more certain, or whether deferring into a future year makes more sense. Below are some initial considerations for those that have options, ESPPs or company stock in a 401(k).

Exercising the appropriate balance of ISOs and NSOs can yield an optimal tax outcome if the underlying fundamentals of the company stock dictate that exercising in the near-term may make sense. ISOs generate AMT (alternative minimum tax) income, but if special rules are followed will never generate ordinary income tax (just capital gains upon sale). NSOs on the other hand generate ordinary income when they are exercised. While it is more difficult to be exposed to AMT now following the 2017 Federal Tax Reform, if a large enough combination of ISO exercises and other income tax events occur in a given year, it can become quite a real issue for a taxpayer. In some instances, it may make sense to exercise NSOs as well to lessen the AMT impact from ISOs. This often requires a detailed tax projection to attain the optimal outcome, so be certain to consult with a qualified tax or financial professional before engaging.
Those with company stock through an ESPP may want to manage their tax exposure while decreasing their concentration risk by staging their sales around year-end. Proper understanding of the discount income and your holding period requirements is recommended before disposing of ESPP stock.
401(k) participants that have company stock in their company plan can take advantage of the Net Unrealized Appreciation (NUA) strategy. This strategy allows a 401(k) to be rolled over to an IRA, with the exception of the company stock within the 401(k) being transferred into a taxable account. The amount of company stock that was contributed into the original 401(k) over the years is considered ordinary income when moved to the taxable account, but any of the appreciation is capital gain and only realized upon the eventual sale of the stock - not at transfer. This can be desirable rather than leaving the company stock in the 401(k) and years later having to pay a higher, ordinary income tax rate on the entire balance when distributed.
The relevance of this strategy to year-end, is that it is only permissible if the entire account is rolled over within the same calendar year that the rollover was first initiated. There are very specific rules that apply to NUA eligibility, but for those that may qualify and would like to implement this strategy in 2019, be sure to complete all necessary transfers and rollovers before the year is through, otherwise the entire strategy will not be permitted by the IRS.

Disclosure: Hudson Oak Wealth Advisory LLC (“Hudson Oak” or “Hudson Oak Wealth”) is a registered investment adviser in the State of New Jersey & New York. For information pertaining to Hudson Oak’s registration status, its fees and services and/or a copy of our Form ADV disclosure statement, please contact Hudson Oak. A full description of the firm’s business operations and service offerings is contained in Part 2A of Form ADV. Please read this Part 2A carefully before you invest. This article contains content that is not suitable for everyone and is limited to the dissemination of general information pertaining to Hudson Oak’s Wealth Advisory & Management, Financial Planning and Investment services. Past performance is no guarantee of future results, and there is no guarantee that the views and opinions expressed in this presentation will come to pass. Investments involve risks and may lose value. Figures displayed within this communication are for illustrative purposes only. Nothing contained herein should be interpreted as legal, tax or accounting advice nor should it be construed as personalized Wealth Advisory & Management, Financial Planning, Tax, Investing, or other advice. For legal, tax and accounting-related matters, we recommend that you seek the advice of a qualified attorney or accountant. This article is not a substitute for personalized planning from Hudson Oak. The content is current only as of the date on which this article was written. The statements and opinions expressed are subject to change without notice based on changes in the law and other conditions.